As you’ve probably heard, the DC Circuit struck down the SEC’s proxy access rule last month, in Business Roundtable and Chamber of Commerce v. SEC. The three-judge panel held that the SEC’s proxy access rule was “arbitrary and capricious” because the SEC failed “adequately to assess the economic effects of a new rule.” Unlike most securities lawyers, to whom proxy access is a huge deal, I personally don’t find proxy access terribly interesting. But the Business Roundtable decision will affect many future SEC rules required under Dodd-Frank, so it’s important to consider the decision, and how the SEC should proceed in light of the decision.

For a variety of reasons, I think the DC Circuit’s decision was terrible — hilariously biased, and generally not worth the paper it was written on. (Not surprisingly, the opinion was written by failed Reagan Supreme Court nominee Douglas Ginsburg, who also wrote the 2005 opinion striking down another SEC rule.)

In the court’s words:

[T]he Commission has a unique obligation to consider the effect of a new rule upon “efficiency, competition, and capital formation,” 15 U.S.C. §§ 78c(f), 78w(a)(2), 80a-2(c), and its failure to “apprise itself — and hence the public and the Congress — of the economic consequences of a proposed regulation” makes promulgation of the rule arbitrary and capricious and not in accordance with law.

The SEC did, in fact, engage in an unusually lengthy cost-benefit analysis in its proposed rule and its final rule. But the court, clearly determined to find some reason to strike down the proxy access rule, found a few arguments raised by commenters that the SEC didn’t completely and definitively rebut, and used that to conclude that the SEC had failed to adequately consider the effect of the new rule on “efficiency, competition, and capital formation.”

As a preliminary matter, I think the court’s reasoning was comically weak. On one issue, the court conceded that the empirical evidence was “mixed,” but then bizarrely refused to allow the SEC any deference whatsoever in arbitrating between competing empirical studies. In other words, the SEC chose to believe the empirical studies that went against the court’s policy preferences. Awesome. On another issue, the court faulted the SEC for not irrationally assuming that “union and government pension funds” would use the proxy access rule to harm “shareholder value.” (Remember when conservatives used to argue that employee ownership schemes would promote glorious efficiency by aligning the interests of labor and management? I miss those days.)

So what should the SEC — which has to write a slew of regulations implementing Dodd-Frank in the next few years — do in light of the Business Roundtable decision? First, where it’s able to, the SEC should certainly humor the DC Circuit and engage in a (very) detailed cost-benefit analysis.

Second, and more importantly, the SEC shouldn’t be afraid to admit that a proposed rule won’t necessarily maximize “efficiency, competition, and capital formation.” The DC Circuit can’t strike down an SEC rule on the grounds that it doesn’t promote “efficiency, competition, and capital formation.” Let’s look at the statute, 15 U.S.C. § 78c(f):

Whenever pursuant to this chapter the Commission is engaged in rulemaking, or in the review of a rule of a self-regulatory organization, and is required to consider or determine whether an action is necessary or appropriate in the public interest, the Commission shall also consider, in addition to the protection of investors, whether the action will promote efficiency, competition, and capital formation. (emphasis mine)

The SEC isn’t required to only promulgate rules that will promote efficiency, competition, and capital formation — it’s only required to consider those factors. And that’s in addition to another, separate, factor — the protection of investors. So if the SEC can’t prove that one of its proposed rules will promote efficiency, competition, and capital formation, the agency can still issue the rule on the grounds that it protects investors. The other relevant statute, 15 U.S.C. § 78w(a)(2), simply requires the SEC to determine that any harm to competition caused by a proposed rule is “appropriate in furtherance of the purposes of” the ’34 Act — which includes investor protection. The Business Roundtable decision just means that the SEC has to lay out its efficiency analysis in detail, even if the conclusion is that the rule won’t promote efficiency.

Essentially, the SEC shouldn’t be afraid to tell the DC Circuit to take its “efficiency, competition, and capital formation” analysis and shove it, and that investor protection is still paramount, thank you very much. Not in those words, of course. But you get the idea.

One of the major "flaws" of the SEC's economic analysis was its failure to recognize the amount companies would spend in campaigns to retain entrenched directors through:

“significant media and public relations efforts, advertising …, mass mailings, and other communication efforts, as well as the hiring of outside advisors and the expenditure of significant time and effort by the company’s employees.”

To reduce the likelihood of excess spending, all candidates, including the board’s own nominees, should be required to file pre and post election estimates and accounting of all campaign expenditures including in-kind contributions and those expended by the corporations or other entities on behalf of candidates they support. Sunlight may still be the best disinfectant we can hope for.

I'm still fighting for a universal proxy that would list all legally nominated candidates.

The costs of proxy access can be substantial only in comparison to the revenues of the corporation. For a company such as, say, GE, proxy costs would have to be how much to substantial? Tens of millions? Hundreds? Billions? More than the auditors' floor for materiality?

Auditors have a shortcut in determining materiality. It's usually 3% of revenues. GE had $148 billion in revenues last year. Based on the unofficial 3% materiality standard, proxy costs for GE would be material only if they exceeded about $4 billion.

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Basically, the SEC should not be scared to tell the DC Routine to take its “efficiency, competitors, and investment formation” research and leave it, and that trader security is still critical, thank you very much. Not in those terms, of course. But you get the concept.

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About Me

I'm a finance lawyer in New York. I used to focus on derivatives and structured finance (you know, back when there was a structured finance market). I spent the majority of my career at one of the major investment banks. My background is in economics and, unfortunately, politics.

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